CFS BANCORP INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

COMMISSION FILE NO.: 0-24611

CFS BANCORP, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 35-2042093
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)

707 RIDGE ROAD 46321
MUNSTER, INDIANA (Zip Code)
(Address of Principal Executive Offices)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(219) 836-9990

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NOT APPLICABLE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

COMMON STOCK (PAR VALUE $0.01 PER SHARE)
(Title of Class)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 month (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]

As of June 30, 2004, the aggregate value of the 12,290,934 shares of Common
Stock of the Registrant outstanding on such date, which excludes 708,157 shares
held by all directors and executive officers of the Registrant as a group, was
approximately $153.5 million. This figure is based on the last known trade price
of $13.25 per share of the Registrant's Common Stock on June 30, 2004.

Number of shares of Common Stock outstanding as of March 11, 2005:
12,382,322

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement for the Annual Meeting of
Stockholders to be held on April 26, 2005 are incorporated by reference into
Part III.
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CFS BANCORP, INC. AND SUBSIDIARIES

FORM 10-K

INDEX

1

When used in this Annual Report on Form 10-K or future filings by the
Company with the Securities and Exchange Commission (SEC), in the Company's
press releases or other public or stockholder communications, the words or
phrases "would be," "will allow," "intends to," "will likely result," "are
expected to," "will continue," "is anticipated," "estimate," "project," or
similar expressions, or the negative thereof, are intended to identify
"forward-looking statements" within the meaning of the Private Litigation Reform
Act of 1995.

The Company wishes to caution readers not to place undue reliance on any
such forward-looking statements, which speak only as of the date made, and to
advise readers that various factors, including regional and national economic
conditions, changes in levels of market interest rates, credit and other risks
which are inherent in the Company's lending and investment activities,
legislative changes, changes in the cost of funds, demand for loan products and
financial services, changes in accounting principles and competitive and
regulatory factors, could affect the Company's financial performance and could
cause the Company's actual results for future periods to differ materially from
those anticipated or projected. Such forward-looking statements are not
guarantees of future performance. The Company does not undertake, and
specifically disclaims any obligation, to update any forward-looking statements
to reflect occurrences or unanticipated events or circumstances after the date
of such statements.

PART I.

ITEM 1. BUSINESS

GENERAL

CFS Bancorp, Inc. (including its consolidated subsidiaries, the Company) is
a registered unitary savings and loan holding company and was organized in March
1998 to facilitate the July 1998 conversion of its subsidiary, Citizens
Financial Services, FSB (the Bank or Citizens Financial), from a
federally-chartered mutual savings bank to a federally-chartered stock savings
bank (Conversion). In conjunction with the Conversion, the Company completed an
initial public offering. The Company and the Bank are subject to oversight and
examination by the Office of Thrift Supervision (OTS). See
"Regulation -- Regulation of Savings and Loan Holding Companies."

The Company's primary assets consist of the outstanding shares of common
stock of the Bank and the Company's loan to the Bank for the employee stock
ownership plan (ESOP). The Company has no significant liabilities. The
management of the Company and the Bank are substantially identical. The Company
neither owns nor leases any property but instead uses the premises, equipment
and furniture of the Bank. The Company does not employ any persons other than
officers who are also officers of the Bank. In addition, the Company utilizes
the support staff of the Bank from time to time. Additional employees may be
hired as appropriate to the extent the Company expands or changes its business
in the future.

The Bank is subject to examination and comprehensive regulation by the OTS,
which is the Bank's chartering authority and primary federal regulator. The Bank
is also regulated by the Federal Deposit Insurance Corporation (FDIC),
administrator of the Savings Association Insurance Fund (SAIF). The Bank is also
subject to certain reserve requirements established by the Board of Governors of
the Federal Reserve System (FRB) and is a member of the Federal Home Loan Bank
(FHLB) of Indianapolis, which is one of the 12 regional banks comprising the
FHLB System.

The Bank was originally organized in 1934 and conducts its business from
its executive offices in Munster, Indiana, as well as 24 banking centers located
in Lake and Porter Counties in northwest Indiana and Cook, DuPage and Will
Counties in Illinois. The Bank also has an Operations Center located in
Highland, Indiana which is dedicated to its Customer Call Center and other back
office operations.

The Bank's revenue is derived from interest on loans, mortgage-backed and
related securities and investments, loan and deposit fees, and investment
commissions. The Bank's operations are significantly impacted by general and
economic conditions, the monetary policy of the federal government, including
the FRB, legislative tax policies and governmental budgetary matters. The Bank's
revenue has been largely dependent on net interest income, which is the
difference between interest earned on interest-bearing assets
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and the interest expense paid on interest-bearing liabilities. However, the Bank
continues to focus on generating other sources of income through loan and
deposit fees, investment commissions and other non-interest income to be a
significant source of revenue.

AVAILABLE INFORMATION

CFS Bancorp, Inc. is a public company and files annual, quarterly and
special reports, proxy statements and other information with the Securities and
Exchange Commission. The Company's filings are available to the public at the
SEC's web site at http://www.sec.gov. Members of the public may also read and
copy any document the Company files at the SEC's Public Reference Room at 450
Fifth Street, N.W., Washington, DC 20549. You can request copies of these
documents by writing to the SEC and paying a fee for the copying cost. Please
call the SEC at 1-800-SEC-0330 for more information about the operation of the
public reference room. In addition, the Company's stock is listed for trading on
the NASDAQ National Market and trades under the symbol "CITZ." You may find
additional information regarding the Company at www.nasdaq.com.

In addition to the foregoing, the Company maintains an internet website at
www.cfsbancorp.com. The Company makes copies of its Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments
to such documents on its website as soon as reasonably practicable after it
files such material with or furnishes such documents to the SEC.

CORPORATE GOVERNANCE

The Company has established certain committees of its Board of Directors,
specifically audit, compensation, and nominating committees. The charters of
these committees as well as the Company's Code of Conduct and Ethics can be
found on the above mentioned Company website. The information is also available
in printed form to any shareholder who requests it by writing to the Company in
care of the Vice President -- Corporate Secretary, 707 Ridge Road, Munster,
Indiana 46321.

MARKET AREA AND COMPETITION

Citizens Financial maintains 24 banking centers in Lake and Porter Counties
in northwest Indiana and in Cook, DuPage and Will Counties in Illinois. The
areas served by Citizens Financial are part of the Chicago Metropolitan
Statistical Area.

The Bank has historically concentrated its efforts in the market
surrounding its offices and has in recent years broadened that market into the
Midwestern United States mainly through the development of commercial lending
relationships. The Bank's market area reflects diverse socioeconomic factors.
Traditionally, the market area in northwest Indiana and the suburban areas south
of Chicago were dependent on heavy manufacturing. While manufacturing is still
an important component of the local economies, service-related industries have
become increasingly significant to the region in the last decade. Growth in the
local economies can be expected to occur largely as a result of the continued
interrelation with Chicago as well as suburban business centers in the area.

The Bank faces significant competition both in making loans and in
attracting deposits. The Chicago metropolitan area is one of the largest money
centers in the United States, and the market for deposit funds is highly
competitive. The Bank's competition for loans comes principally from commercial
banks, other savings banks, savings associations and mortgage-banking companies.
The Bank's most direct competition for deposits has historically come from
savings banks, commercial banks and credit unions. The Bank faces additional
competition for deposits from short-term money market funds, other corporate and
government securities funds and other non-depository financial institutions such
as brokerage firms and insurance companies.

LENDING ACTIVITIES

General. Citizens Financial originates commercial and retail loans.
Included in the Bank's commercial loan portfolio are commercial real estate,
construction and land development, and commercial and industrial loans. The
retail loan portfolio includes single-family residential mortgage loans, home
equity loans and lines

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of credit (together, HELOCs) and other consumer loans including auto loans.
Since the Conversion, the Bank shifted its lending emphasis, increasing its
involvement in commercial loans, while concurrently reducing its originations of
single-family residential mortgage loans.

The Bank's lending strategy is to diversify its portfolio in an effort to
limit risks associated with any particular loan type or industry while building
a quality loan portfolio. The Bank has established specific collateral
concentration limits in a manner that will not hamper its lenders in the pursuit
of new business in a variety of sectors.

The Bank's commercial loan underwriting focuses on the financial strength
of the borrower and guarantors, the cash flow of a business, and the underlying
collateral. While the Bank offers both fixed- and adjustable-rate loan products,
its emphasis remains on originating adjustable-rate loans, which management
believes will better control its interest rate risk.

The Bank utilizes secondary market standards for underwriting single-family
residential mortgage loans which facilitates its ability to sell these loans
into the secondary market. Secondary market requirements place limitations on
debt to income ratios and loan size among other factors. As part of the
underwriting process, the Bank evaluates, among other things, the customers'
credit history, income, employment stability, repayment capacity and collateral.

The Bank utilizes a Risk-Based Lending (RBL) approach for underwriting
HELOCs and other consumer loans. The RBL approach employed by the Bank evaluates
the borrower's credit score, debt-to-income ratio and the loan's collateral
value. Borrowers with a higher credit score generally qualify for a lower
interest rate.

The types of loans that the Bank may originate are subject to federal and
state laws and regulations. Interest rates charged by the Bank on loans are
affected principally by the demand for such loans, the supply of money available
for lending purposes, the rates offered by its competitors and the risks
involved on such loans. These factors are, in turn, affected by general and
economic conditions, the monetary policy of the federal government, including
the FRB, legislative tax policies and governmental budgetary matters.

Certain officers of the Bank have been authorized by the Board of Directors
to approve loans up to certain designated amounts. The Loan Committee of
Citizens Financial meets weekly and reviews all loans that exceed individual
loan approval authorities. All new loans are reviewed by the full Board of
Directors of Citizens Financial as part of its monthly review of the Loan
Committee minutes.

A federal savings bank generally may not make loans to one borrower and
related entities in an amount which exceeds 15% of its unimpaired capital and
surplus (or approximately $19.0 million in the case of the Bank at December 31,
2004), although loans in an amount equal to an additional 10% of unimpaired
capital and surplus may be made to a borrower if the loans are fully secured by
readily marketable securities. Since January 2003, the Bank has had a general
guideline of limiting any one loan or multiple loans to the same borrower to 75%
of the regulatory limit.

The Bank is also required to monitor its aggregate loans to corporate
groups. These are loans that are given to individual entities that have a
similar ownership group but are not considered to be a common enterprise. While
the individual loans are secured by separate property and underwritten based on
separate cash flows, the entities may all be owned or controlled by one
individual or a group of individuals. The Bank is required by regulation to
limit its aggregate loans to any corporate group to 50% of Tier 1 capital. At
December 31, 2004, Tier 1 capital was $120.1 million. Citizens Financial's two
largest corporate group relationships at December 31, 2004 equaled $40.9 million
and $24.1 million, respectively. Both of these relationships are below the group
limit of $60.1 million and are performing in accordance with their terms.

COMMERCIAL AND CONSTRUCTION LENDING

General. In recent years, the Company's strategy has changed with respect
to its loan portfolio as the Company has significantly increased its emphasis on
originating commercial loans. The Company increased the number of experienced
commercial loan officers and employees to build a regionally structured
Commercial Loan Department. The regional structure allows the loan officers to
build relationships with the

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businesses in their communities and to tailor business development plans based
on the needs of that specific area. While the commercial lending group develops
business relationships within its market area, they also pursue commercial
lending opportunities outside the Bank's market area through participations with
other financial institutions.

Commercial Real Estate. The majority of the Bank's commercial loan
portfolio is made up of loans secured by commercial real estate, including
multi-family residential loans. These loans generally have 3 to 10 year terms
with an amortization period of 25 years or less. The interest rates on these
loans are generally fixed for the first five years followed by a one time
adjustment which then becomes the fixed-rate of the loan for the remaining term.
The Bank has also offered loans with a fixed interest rate for an initial three
or five year period and which then adjusts annually to a designated index such
as one-year U.S. Treasury obligations adjusted to a constant maturity (CMT) plus
a stipulated margin for the remainder of the term. Commercial real estate loans
generally have shorter terms to maturity and higher yields than the Bank's
single-family residential mortgage loans. Upon closing, the Bank usually
receives fees of between 0.5% and 1.0% of the principal loan balance. These
loans are typically subject to prepayment penalties. The Bank generally obtains
personal guarantees of the borrower's principals as additional security for any
commercial real estate loans.

Citizens Financial evaluates various aspects of commercial real estate loan
transactions in an effort to mitigate credit risk. In underwriting these loans,
consideration is given to the stability of the property's cash flow history,
future operating projections, management experience, current and projected
occupancy, market position, location and physical condition. In addition, the
Bank also performs sensitivity analysis on cash flow, vacancy trends and
interest rate projections when underwriting the loans to determine how different
scenarios may impact the borrowers' ability to repay the loans. The Bank has
generally imposed a debt coverage ratio (the ratio of net income before payment
of debt service to debt service) of not less than 110% for commercial real
estate loans. The underwriting analysis also includes credit checks and a review
of the financial condition of the borrower and guarantor. An appraisal report is
prepared by an independent appraiser commissioned by the Bank to substantiate
property values for new commercial real estate loan transactions. All appraisal
reports and any necessary environmental site assessments are reviewed by the
Bank before the loan closes.

Commercial real estate lending entails substantially different risks
compared to single-family residential lending because such loans often involve
large loan balances to single borrowers and because the payment experience on
these loans is typically dependent on the successful operation of the project or
the borrower's business. These risks can also be significantly affected by
supply and demand conditions in the local market for apartments, offices,
warehouses, or other commercial space. The Bank attempts to minimize its risk
exposure by considering properties with existing operating performance which can
be analyzed, requiring conservative debt coverage ratios and periodically
monitoring the operation and physical condition of the collateral as well as the
business occupying the property.

The Bank also invests, on a participating basis, in commercial real estate
loans originated by other lenders. In these transactions, the Bank reviews such
loans utilizing the same credit policies applicable to loans it originates.

The Bank's commercial real estate loans are secured by hotels, medical
office facilities, multi-family residential buildings, churches, small office
buildings, strip shopping centers and other commercial uses. These loans are
usually originated in amounts of less than $15.0 million, and as of December 31,
2004, the average size of the Bank's commercial real estate loans was
approximately $1.1 million.

Construction and Land Development Loans. The Bank currently offers
construction loans for commercial real estate and multi-family residential
properties along with construction loans to local residential builders. The
Bank's construction portfolio also includes construction/permanent,
single-family residential loans which, by their terms, will convert to permanent
mortgage loans upon the completion of their construction. At the time of
conversion, these loans will become part of the Bank's single-family residential
mortgage loan portfolio.

The Bank also originates land loans to local developers for the purpose of
developing the land (i.e., roads, sewer and water) for sale. These loans are
secured by a mortgage on the property which is generally limited to

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the lesser of 75% of its appraised value or 75% of its cost and are typically
made for a period of up to three years. The Bank requires monthly interest
payments during the term of the loan. The principal of the loan is reduced as
lots are sold and released. All of the Bank's land loans are secured by property
located in its primary market area. In addition, the Bank generally obtains
personal guarantees from the borrower's principals for construction and land
development loans.

The Bank's loan underwriting and processing procedures require a property
appraisal by an approved independent appraiser and that each construction and
development loan is reviewed by independent architects, engineers or other
qualified third parties for verification of costs. Disbursements during the
construction phase are based on regular on-site inspections and approved
certifications. In the case of construction loans on commercial projects where
the Bank provides the permanent financing, the Bank usually requires firm lease
commitments on some portion of the property under construction from qualified
tenants. In addition, the Bank primarily provides residential and commercial
construction lending within the Midwestern United States.

Construction and development financing is generally considered to involve a
higher degree of risk of loss than long-term financing on improved,
owner-occupied real estate. The Bank's risk of loss on a construction loan is
dependent largely upon the accuracy of the initial estimate of the property's
value at completion of construction or development and the estimated cost
(including interest) of construction. If the estimate of construction cost
proves to be inaccurate, the Bank first requires the borrower to inject cash
equity to cover any shortfall. The Bank may then need to advance funds beyond
the amount originally committed to permit completion of the development.

In evaluating any new originations of construction and development loans,
the Bank generally considers evidence of the availability of permanent financing
or a takeout commitment to the borrower, the reputation of the borrower and the
contractor, the amount of the borrower's equity in the project, independent
valuations and reviews of cost estimates, pre-construction sale and leasing
information, and cash flow projections of the borrower. To reduce the inherent
lending risk, the Bank may require performance bonds in the amount of the
construction contract and often obtains personal guarantees from the principals
of the borrower.

At December 31, 2004, the average size of the Bank's construction and land
development loans was approximately $810,000.

Commercial and Industrial Loans. The Bank also originates commercial loans
that are secured by business assets other than real estate and secured and
unsecured operating lines of credit. These types of loans undergo an
underwriting process similar to the other types of commercial lending the Bank
offers; however, these loans tend to be riskier in nature since the repayment is
based on the cash flows of the business operation. As of December 31, 2004, the
average size of the Bank's commercial and industrial loans was approximately
$250,000.

RETAIL LENDING

General. The Bank's retail lending program includes single-family
residential loans, HELOCs, auto loans and other consumer loans. The Bank's
primary focus continues to be on originating variable-rate retail products,
primarily through its HELOC programs and by retaining any variable-rate
single-family residential loans while selling most fixed-rate loans originated
with servicing released. The Bank's retail lenders are responsible for
originating its retail loans. The retail lenders are also assisted by the Bank's
branch origination program and call center within its market area.

Single-Family Residential Loans. Substantially all of the Bank's
single-family residential mortgage loans consist of conventional loans.
Conventional loans are neither insured by the Federal Housing Administration
(FHA) nor partially guaranteed by the Department of Veterans Affairs (VA). The
vast majority of the Bank's single-family residential mortgage loans are secured
by properties located in Lake and Porter Counties in northwest Indiana and Cook,
DuPage and Will Counties in Illinois.

Citizens Financial's residential mortgage loans have either fixed interest
rates or variable interest rates which adjust periodically during the term of
the loan. Fixed-rate loans generally have maturities of 15 or 30 years and are
fully amortizing with monthly loan payments sufficient to repay the total amount
of the loan
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and interest by the maturity date. Substantially all of the Bank's single-family
residential mortgage loans contain due-on-sale clauses, which permit the Bank to
declare the unpaid balance to be due and payable upon the sale or transfer of
any interest in the property securing the loan. The Bank enforces such
due-on-sale clauses.

The Bank's fixed-rate loans are generally originated under terms,
conditions and documentation which permit them to be pre-sold in the secondary
market for mortgages. By pre-selling these loans, the Bank limits the interest
rate risk associated with fixed rate loans. At December 31, 2004, $60.1 million,
or 21.6% of the Bank's single-family residential mortgage loans, were fixed-rate
loans. During 2004, the Bank sold approximately $13.2 million of fixed-rate
loans with servicing released.

The adjustable-rate single-family residential mortgage (ARM) loans
currently offered by the Bank have interest rates which are fixed for the
initial three or five years and then adjust annually to a CMT plus a stipulated
margin. The Bank's ARMs generally have a cap of 2% on any increase or decrease
in the interest rate at any adjustment date and include a specified cap on the
maximum interest rate over the life of the loan. This cap is generally 6% above
the initial rate. The Bank's ARMs require that any payment adjustment resulting
from a change in the interest rate of an adjustable-rate loan be sufficient to
result in full amortization of the loan by the end of the loan term and, thus,
do not permit any of the increased payment to be added to the principal amount
of the loan, or so-called negative amortization. At December 31, 2004, $218.1
million, or 78.4% of the Bank's single-family residential mortgage loans, were
adjustable-rate loans.

While the Bank has focused on providing ARMs to decrease the risk related
to changes in the interest rate environment, these types of loans also involve
other risks. As interest rates rise, the customers' payments on an ARM also
increases to the extent permitted by the loan terms thereby increasing the
potential for default. Also, when interest rates decline substantially,
borrowers tend to refinance into fixed-rate loans. The Bank believes that these
risks generally are less than the risks associated with holding long-term
fixed-rate loans.

The volume and types of ARMs originated by Citizens Financial are affected
by such market factors as the level of interest rates, competition, consumer
preferences and availability of funds. Accordingly, although the Bank
anticipates that it will continue to offer ARMs, the increased emphasis over the
past few years on growing the Bank's commercial lending portfolio has reduced
the proportion of single-family residential loans to total loans.

The Bank's single-family residential loans generally do not exceed amounts
limited to the maximum amounts contained in U.S. Government sponsored agency
guidelines. In addition, the maximum loan-to-value (LTV) ratio for the Bank's
single-family residential mortgage loans is generally 95% of the secured
property's appraised value, provided that private mortgage insurance is
generally obtained on the portion of the principal amount that exceeds 80% of
the appraised value.

HELOC. The majority of the Bank's home equity products are HELOCs which
are structured as a variable-rate line of credit with terms up to 20 years
including a 10 year repayment period. The Bank also offers home equity loans
with a 10 year term which have a fixed-rate for the first five years and a
one-time rate adjustment after the fifth year. Both types of home equity
products are secured by the underlying equity in the borrower's residence. The
Bank's HELOCs generally require LTV ratios of 90% or less after taking into
consideration any first mortgage loan. However, the most creditworthy customers
may qualify to receive up to 100% LTV. There is a higher risk associated with
this type of lending since the HELOCs are typically secured by a second
mortgage. The Bank looks to the borrower's credit history as an indication of
risk and as a factor in establishing the interest rate on the loan or line of
credit.

Other Loans. Citizens Financial's other retail loans consist primarily of
consumer loans, loans secured by deposit accounts and auto loans. The Bank is
not actively marketing its consumer loans and offers them primarily as a service
to its existing customers.

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SECURITIES ACTIVITIES

The Company's investment policy, which has been established by the Board of
Directors, is designed to prescribe authorized investments and outline the
Company's practices for managing risks involved with investment securities. The
policy emphasizes:

- principal preservation,

- favorable returns on investment,

- liquidity within designated guidelines,

- minimal credit risk, and

- flexibility.

The Company's investment policy permits investments in various types of
securities including obligations of the U.S. Treasury, federal agencies,
government sponsored entities, investment grade corporate obligations (A rated
or better), trust preferred stocks, other equity securities, commercial paper,
certificates of deposit, and federal funds sold to financial institutions
approved by the Board of Directors. The Company currently does not participate
in hedging programs, interest rate swaps, or other activities involving the use
of off-balance sheet derivative instruments.

The Company evaluates securities for other-than-temporary (OTT) impairment
on a quarterly basis, and more frequently when economic or market concerns
warrant additional evaluations. In evaluating the possible impairment of
securities, consideration is given to the length of time and the extent to which
the fair value has been less than cost, the financial conditions and near-term
prospects of the issuer, and the intent and ability of the Company to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. In analyzing an issuer's financial
condition, the Company may consider whether the securities are issued by the
federal government or its agencies, whether downgrades by bond rating agencies
have occurred, and the results of reviews of the issuer's financial condition.
The Company has the intent to recover the costs associated with these securities
but can give no assurance that losses will not be realized if it is deemed that
there will be a future economic benefit in realizing the loss.

If management determines that an investment security has experienced an OTT
decline in value, the loss is recognized in the income statement. Any recoveries
related to the value of these securities are recorded as an unrealized gain (as
other comprehensive income in stockholders' equity) and not recognized in income
until the security is ultimately sold.

The Company currently utilizes an outside investment advisor for developing
and monitoring an investment strategy designed to maximize the portfolio's total
return while maintaining acceptable levels of risk. The Company currently
employs a strategy that maximizes total returns by proactively managing where
securities are purchased and held along the yield curve. An inherent byproduct
of this strategy is the recognition of realized gains and losses. These gains
and losses should be looked upon as part of the portfolio's overall total
return.

SOURCE OF FUNDS

General. Deposits are the primary source of the Bank's funds for lending
and other investment purposes. In addition to deposits, the Bank derives funds
from loan principal repayments, prepayments, and borrowings. Loan repayments are
historically a relatively stable source of funds, while deposit inflows and
outflows are significantly influenced by general interest rates and money market
conditions. The Bank has used borrowings in the past, primarily FHLB advances,
to supplement its deposits as a source of funds.

Deposits. The Bank's deposit products include a broad selection of deposit
instruments, including checking accounts, money market accounts, statement and
passbook savings accounts, and term certificate accounts. The Bank considers its
checking, money market and savings accounts to be its core deposits. Deposit
account terms may vary with principal differences including: (i) the minimum
balance required; (ii) the time periods the funds must remain on deposit; and
(iii) the interest rate paid on the account.
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The Bank utilizes traditional marketing methods to attract new customers
and deposits, and it does not advertise for deposits outside of its market area.
The Bank does not currently utilize the services of deposit brokers. The Bank
traditionally has relied on customer service and convenience in marketing its
deposit products. The Bank has implemented an initiative to attract core
deposits in all markets by offering various limited-time promotions for new
deposit accounts. As the need for funds warrant, the Bank may continue to use
certificate of deposit promotions in new markets to build its customer base.

Borrowings. Although deposits are the Bank's primary source of funds, the
Bank's policy has been to utilize borrowings, such as advances from the FHLB.
The advances from the FHLB of Indianapolis are secured by capital stock of the
FHLB of Indianapolis, a blanket pledge of certain of the Bank's mortgage loans,
investment securities, and mortgage-backed securities and the FHLB of
Indianapolis time deposits. These advances are made in accordance with several
different credit programs, each of which has its own interest rate and range of
maturities.

TRUST ACTIVITIES

The Company also provides limited fiduciary services through the Bank's
Trust Department primarily for convenience to its existing customers. Services
offered include fiduciary services for trusts and estates and land trusts. Prior
to December 31, 2004, the Trust Department maintained 23 trust/fiduciary
accounts with an aggregate principal balance of $1.0 million at such date. The
Trust Department also administered 44 beneficiary-managed land trusts in Indiana
during 2004. Gross revenue from the Trust Department for the year ended December
31, 2004 was $12,000.

The accounts maintained by the Trust Department consist of "managed" and
"non-managed" accounts. Managed accounts are those accounts under custody for
which the Bank has responsibility for administration and investment management
and/or investment advice. Non-managed accounts are those accounts for which the
Bank merely acts as a custodian. The Company receives fees dependent upon the
level and type of service provided. The Trust Department administers various
trust accounts, estates and guardianships.

Most of the significant operations of the Trust Department have been
outsourced to a third-party trust company as of December 31, 2004. It is
anticipated that all further trust prospects, with the exception of Indiana land
trusts, will be referred to the third-party trust company for which the Bank
will receive a referral fee. The Bank anticipates that it will continue to
provide trust services for Indiana land trusts as needed in the future.
Executive management of the Trust Department is provided by the Bank's Senior
Vice President -- Corporate Counsel, subject to direction by the Trust
Committee.

SUBSIDIARIES

During 2004, the Bank had one active, wholly-owned subsidiary, CFS
Holdings, Ltd. (CFS Holdings). This subsidiary was approved by the OTS in
January 2001 and was funded and began operations in June 2001. CFS Holdings is
located in Hamilton, Bermuda. It was funded with approximately $140.0 million of
the Bank's investment securities and performs a significant amount of the Bank's
securities investing activities. Certain of these activities are performed by a
resident agent in Hamilton in accordance with the operating procedures and
investment policy established for CFS Holdings by the Bank. Revenues of CFS
Holdings were $4.7 million for the year ended December 31, 2004 compared to $3.7
million and $5.2 million for the years ended December 31, 2003 and 2002,
respectively. Operating expenses of this subsidiary were $68,000 for the year
ended December 31, 2004 compared to $58,000 and $61,000 for the years ended
December 31, 2003 and 2002, respectively.

Prior to 2003, the Bank had two other subsidiaries which are no longer
active. These subsidiaries were CFS Insurance Agency, Inc. (CFS Insurance) and
CFS Investment Services, Inc. (CFS Investments). CFS Investments was primarily
involved in the sale of mutual funds and other securities to members of the
general public in the Bank's primary market area. In August 2002, the Bank
entered into an agreement to outsource this activity and discontinued providing
these services directly through CFS Investment Services. The outsourcing allowed
the Bank to recognize commission income on the sale of these products while
reducing the operating expenses associated with this subsidiary.
9

CFS Insurance was an independent insurance brokerage subsidiary which
offered a full line of insurance products to the general public. Effective
November 30, 2002 the Bank sold the assets of this agency and entered into a
five year lease, with the purchaser, for the building from which the agency
conducted its operations. In 2004, the Bank sold the building to a third party
for a profit of $220,000.

EMPLOYEES

Citizens Financial had 327 full-time equivalent employees at December 31,
2004. None of these employees is represented by a collective bargaining agent,
and the Bank believes that it enjoys good relations with its personnel.

REGULATION

REGULATION OF SAVINGS AND LOAN HOLDING COMPANIES

The Company is a registered savings and loan holding company. The Home
Owners' Loan Act (HOLA), as amended, and OTS regulations generally prohibit a
savings and loan holding company, without prior OTS approval, from acquiring,
directly or indirectly, the ownership or control of any other savings
association or savings and loan holding company, or all, or substantially all,
of the assets or more than 5% of the voting shares thereof. These provisions
also prohibit, among other things, any director or officer of a savings and loan
holding company, or any individual who owns or controls more than 25% of the
voting shares of such holding company, from acquiring control of any savings
association not a subsidiary of such savings and loan holding company, unless
the acquisition is approved by the OTS.

Holding Company Activities. The Company currently operates as a unitary
savings and loan holding company. Generally, there are limited restrictions on
the activities of a unitary savings and loan holding company and its non-savings
association subsidiaries. If the Company ceases to be a unitary savings and loan
holding company, the activities of the Company and its non-savings association
subsidiaries would thereafter be subject to substantial restrictions.

The HOLA requires every savings association subsidiary of a savings and
loan holding company to give the OTS at least 30 days advance notice of any
proposed dividends to be made on its guarantee, permanent or other
non-withdrawable stock, or else such dividend will be invalid.

Affiliate Restrictions. Transactions between a savings association and its
"affiliates" are subject to quantitative and qualitative restrictions under
Sections 23A and 23B of the Federal Reserve Act. Affiliates of a savings
association include, among other entities, the savings association's holding
company and companies that are under common control with the savings
association.

In general, Sections 23A and 23B and OTS regulations issued in connection
therewith limit the extent to which a savings association or its subsidiaries
may engage in certain "covered transactions" with affiliates to an amount equal
to 10% of the association's capital and surplus, in the case of covered
transactions with any one affiliate, and to an amount equal to 20% of such
capital and surplus, in the case of covered transactions with all affiliates. In
addition, a savings association and its subsidiaries may engage in covered
transactions and certain other transactions only on terms and under
circumstances that are substantially the same, or at least as favorable to the
savings association or its subsidiary, as those prevailing at the time for
comparable transactions with nonaffiliated companies. A "covered transaction" is
defined to include a loan or extension of credit to an affiliate; a purchase of
investment securities issued by an affiliate; a purchase of assets from an
affiliate, with certain exceptions; the acceptance of securities issued by an
affiliate as collateral for a loan or extension of credit to any party; or the
issuance of a guarantee, acceptance or letter of credit on behalf of an
affiliate.

In addition, under OTS regulations, a savings association may not make a
loan or extension of credit to an affiliate unless the affiliate is engaged only
in activities permissible for bank holding companies; a savings association may
not purchase or invest in securities of an affiliate other than shares of a
subsidiary; a savings association and its subsidiaries may not purchase a
low-quality asset from an affiliate; and covered transactions and certain other
transactions between a savings association or its subsidiaries and an affiliate
must be on
10

terms and conditions that are consistent with safe and sound banking practices.
With certain exceptions, each loan or extension of credit by a savings
association to an affiliate must be secured by collateral with a market value
ranging from 100% to 130% (depending on the type of collateral) of the amount of
the loan or extension of credit.

The OTS regulation generally excludes all non-bank and non-savings
association subsidiaries of savings associations from treatment as affiliates,
except to the extent that the OTS or the FRB decides to treat such subsidiaries
as affiliates. The regulation also requires savings associations to make and
retain records that reflect affiliate transactions in reasonable detail and
provides that certain classes of savings associations may be required to give
the OTS prior notice of transactions with affiliates.

Financial Modernization. Under the Gramm-Leach-Bliley Act enacted into law
on November 12, 1999, no company may acquire control of a savings and loan
holding company after May 4, 1999, unless the company is engaged only in
activities traditionally permitted for a multiple savings and loan holding
company or newly permitted for a financial holding company under Section 4(k) of
the Bank Holding Company Act. Existing savings and loan holding companies, such
as the Company, and those formed pursuant to an application filed with the OTS
before May 4, 1999, may engage in any activity including non-financial or
commercial activities provided such companies control only one savings and loan
association that meets the Qualified Thrift Lender test. Corporate
reorganizations are permitted, but the transfer of grandfathered unitary holding
company status through acquisition is not permitted.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (Act)
implemented legislative reforms intended to address corporate and accounting
fraud. In addition to the establishment of a new accounting oversight board
which enforces auditing, quality control and independence standards and is
funded by fees from all publicly traded companies, the bill restricts provision
of both auditing and consulting services by accounting firms. To ensure auditor
independence, any non-audit services being provided to an audit client require
pre-approval by the company's audit committee members. In addition, the audit
partners must be rotated. The bill requires the principal chief executive
officer and the principal chief financial officer to certify to the accuracy of
periodic reports filed with the SEC, subject to civil and criminal penalties if
they knowingly or willfully violate this certification requirement. In addition,
under the Act, counsel is required to report evidence of a material violation of
the securities laws or a breach of fiduciary duty by a company to its chief
executive officer or its chief legal officer, and, if such officer does not
appropriately respond, to report such evidence to the audit committee or other
similar committee of the Board of Directors or the Board itself.

The Act extended the period during which certain types of suits can be
brought against a company or its officers and provides for disgorgement of
bonuses issued to top executives prior to restatement of a company's financial
statements if such restatement was due to corporate misconduct and a range of
enhanced penalties for corporate executives who are guilty of fraud or other
violations. Executives are also prohibited from insider trading during
retirement plan "blackout" periods, and loans to company executives are
restricted. In addition, a provision directs that civil penalties levied by the
SEC as a result of any judicial or administrative action under the Act be
deposited to a fund for the benefit of harmed investors. The Federal Accounts
for Investor Restitution (FAIR) provision also requires the SEC to develop
methods of improving collection rates. The legislation accelerated the time
frame for disclosures by public companies, as they must immediately disclose any
material changes in their financial condition or operations. Directors and
executive officers must also provide information for most changes in ownership
in a company's securities within two business days of the change.

The Act also increases the oversight of, and codifies certain requirements
relating to audit committees of public companies and how they interact with the
company's registered public accounting firm (RPAF). Audit committee members must
be independent and are barred from accepting consulting, advisory or other
compensatory fees from the issuer. In addition, companies must disclose whether
at least one member of the committee is a "financial expert" as defined by the
SEC and if not, why not. Under the Act, a RPAF is prohibited from performing
statutorily mandated audit services for a company if such company's chief
executive officer, chief financial officer, comptroller, chief accounting
officer or any person serving in equivalent positions has been employed by such
firm and participated in the audit of such company during the

11

one-year period preceding the audit initiation date. The Act also prohibits any
officer or director of a company or any other person acting under their
direction from taking any action to fraudulently influence, coerce, manipulate
or mislead any independent public or certified accountant engaged in the audit
of the company's financial statements for the purpose of rendering the financial
statement's materially misleading. The Act also requires the SEC to prescribe
rules requiring inclusion of an internal control report and assessment by
management in the annual report to shareholders. The Act requires the RPAF that
issues the audit report to attest to and report on management's assessment of
the company's internal controls. In addition, the Act requires that each
financial report required to be prepared in accordance with (or reconciled to)
U.S. generally accepted accounting principles and filed with the SEC reflect all
material correcting adjustments that are identified by a RPAF in accordance with
U.S. generally accepted accounting principles and the rules and regulations of
the SEC. Pursuant to the regulations of the SEC and its Exemptive Order dated
November 30, 2004, the Company anticipates that management's annual report and
the related attestation report of the Company's RPAF will be timely filed as an
amendment to this Annual Report on Form 10-K. See Item 9A of this Form 10-K
below.

REGULATION OF FEDERAL SAVINGS BANKS

As a federally insured savings bank, lending activities and other
investments of the Bank must comply with various statutory and regulatory
requirements. The Bank is regularly examined by the OTS and must file periodic
reports concerning its activities and financial condition.

Although the OTS is the Bank's primary regulator, the FDIC has "backup
enforcement authority" over the Bank. The Bank's eligible deposit accounts are
insured by the FDIC under the SAIF, up to applicable limits.

Federal Home Loan Banks. The Bank is a member of the FHLB System. Among
other benefits, FHLB membership provides the Bank with a central credit
facility. The Bank is required to own capital stock in a FHLB in an amount equal
to at least 1% of its aggregate unpaid single-family and multi-family
residential mortgage loans, home purchase contracts and similar obligations at
the beginning of each calendar year or 5% of its advances from the FHLB,
whichever is greater.

Regulatory Capital Requirements. OTS capital regulations require savings
banks to satisfy minimum capital standards: risk-based capital requirements, a
leverage requirement, and a tangible capital requirement. Savings banks must
meet each of these standards in order to be deemed in compliance with OTS
capital requirements. In addition, the OTS may require a savings association to
maintain capital above the minimum capital levels.

All savings banks are required to meet a minimum risk-based capital
requirement of total capital (core capital plus supplementary capital) equal to
8% of risk-weighted assets (which includes the credit risk equivalents of
certain off-balance sheet items). In calculating total capital for purposes of
the risk-based requirement, supplementary capital may not exceed 100% of core
capital. Under the leverage requirement, a savings bank is required to maintain
core capital equal to a minimum of 3% of adjusted total assets. In addition,
under the prompt corrective action provisions of the OTS regulations, all but
the most highly-rated institutions must maintain a minimum leverage ratio of 4%
in order to be adequately capitalized. A savings bank is also required to
maintain tangible capital in an amount at least equal to 1.5% of its adjusted
total assets.

These capital requirements are viewed as minimum standards by the OTS, and
most institutions are expected to maintain capital levels well above the
minimum. In addition, the OTS regulations provide that minimum capital levels
higher than those provided in the regulations may be established by the OTS for
individual savings associations, upon a determination that the savings
association's capital is or may become inadequate in view of its circumstances.
The OTS regulations provide that higher individual minimum regulatory capital
requirements may be appropriate in circumstances where, among others: (i) a
savings association has a high degree of exposure to interest rate risk,
prepayment risk, credit risk, concentration of credit risk, certain risks
arising from nontraditional activities, and similar risks of a high proportion
of off-balance sheet risk; (ii) a savings association is growing, either
internally or through acquisitions, at such a rate
12

that supervisory problems are presented and are not managed adequately under OTS
regulations; and (iii) a savings association may be adversely affected by
activities or condition of its holding company, affiliates, subsidiaries or
other persons or savings associations with which it has significant business
relationships. The Bank is not subject to any such individual minimum regulatory
capital requirement.

The Bank's tangible and core capital ratios were 9.24%, and its total
risk-based capital ratio was 12.23% at December 31, 2004. At such date, the Bank
met the capital requirements of a "well-capitalized" institution under
applicable OTS regulations.

Certain Consequences of Failure to Comply with Regulatory Capital
Requirements. Any savings bank not in compliance with all of its capital
requirements is required to submit a capital plan that addresses the bank's need
for additional capital and meets certain additional requirements. While the
capital plan is being reviewed by the OTS, the savings bank must certify, among
other things, that it will not, without the approval of its appropriate OTS
Regional Director, grow beyond net interest credited or make capital
distributions. If a savings bank's capital plan is not approved, the bank will
become subject to additional growth and other restrictions. In addition, the
OTS, through a capital directive or otherwise, may restrict the ability of a
savings bank not in compliance with the capital requirements to pay dividends
and compensation, and may require such a bank to take one or more of certain
corrective actions, including, without limitation: (i) increasing its capital to
specified levels, (ii) reducing the rate of interest that may be paid on savings
accounts, (iii) limiting receipt of deposits to those made to existing accounts,
(iv) ceasing issuance of new accounts of any or all classes or categories except
in exchange for existing accounts, (v) ceasing or limiting the purchase of loans
or the making of other specified investments, and (vi) limiting operational
expenditures to specified levels. Noncompliance with the standards established
by the OTS or other regulators may also constitute grounds for other enforcement
action by the federal banking regulators, including cease and desist orders and
civil monetary penalty assessments.

The HOLA permits savings banks not in compliance with the OTS capital
standards to seek an exemption from certain penalties or sanctions for
noncompliance. Such an exemption will be granted only if certain strict
requirements are met and must be denied under certain circumstances. If an
exemption is granted by the OTS, the savings bank still may be subject to
enforcement actions for other violations of law or unsafe or unsound practices
or conditions.

Prompt Corrective Action. The prompt corrective action regulation of the
OTS, promulgated under the Federal Deposit Insurance Corporation Improvement Act
of 1991, requires certain mandatory actions and authorizes certain other
discretionary actions to be taken by the OTS against a savings bank that falls
within certain undercapitalized capital categories specified in the regulation.
The regulation establishes five categories of capital classification:
"well-capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized" and "critically undercapitalized." Under the regulation, the
ratio of total capital to risk-weighted assets, core capital to risk-weighted
assets and the leverage ratio are used to determine an institution's capital
classification. At December 31, 2004, the Bank met the capital requirements of a
"well-capitalized" institution under applicable OTS regulations.

Capital Distribution Regulation. In January 1999, the OTS amended its
capital distribution regulation to bring such regulations into greater
conformity with the other bank regulatory agencies. Specifically, savings
associations that would be well-capitalized following a capital distribution are
not subject to any requirement for notice or application unless the total amount
of all capital distributions, including any proposed capital distribution, for
the applicable calendar year would exceed an amount equal to the savings bank's
net income for that year to date plus the savings bank's retained net income for
the preceding two years. However, because the Bank is a subsidiary of a savings
and loan holding company, the Bank is required to give the OTS at least 30 days
notice prior to any capital distribution to the Company.

Qualified Thrift Lender Test. In general, savings associations are
required to maintain at least 65% of their portfolio assets in certain qualified
thrift investments (which consist primarily of loans and other investments
related to residential real estate and certain other assets). A savings
association that fails the qualified thrift lender test is subject to
substantial restrictions on activities and to other significant penalties. A
savings association may qualify as a qualified thrift lender not only by
maintaining 65% of portfolio assets in
13

qualified thrift investments but also, in the alternative, by qualifying under
the Internal Revenue Code as a "domestic building and loan association." The
Bank is a domestic building and loan association as defined in the Code.

FDIC Assessments. The deposits of the Bank are insured to the maximum
extent permitted by the SAIF, which is administered by the FDIC, and are backed
by the full faith and credit of the U.S. Government. As insurer, the FDIC is
authorized to conduct examinations of, and to require reporting by, FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging in
any activity the FDIC determines by regulation or order to pose a serious threat
to the FDIC. The FDIC also has the authority to initiate enforcement actions
against savings institutions, after giving the OTS an opportunity to take such
action.

Under FDIC regulations, institutions are assigned to one of three capital
groups for insurance premium purposes -- "well-capitalized," "adequately
capitalized" and "undercapitalized" -- which are defined in the same manner as
the regulations establishing the prompt corrective action system, as discussed
above. These three groups are then divided into subgroups which are based on
supervisory evaluations by the institution's primary federal regulator,
resulting in nine assessment classifications. Effective January 1, 1997,
assessment rates for both SAIF-insured institutions and Bank Insurance
Fund-insured institutions ranged from 0% of insured deposits for
well-capitalized institutions with minor supervisory concerns to 0.27% of
insured deposits for undercapitalized institutions with substantial supervisory
concerns. The Bank's deposit insurance premiums totaled $139,000, or 0.015%, of
its insured deposits for the year ended December 31, 2004.

The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. There are no pending proceedings to terminate the deposit insurance of
the Bank.

Community Reinvestment Act and the Fair Lending Laws. Savings institutions
have a responsibility under the Community Reinvestment Act (CRA) and related
regulations of the OTS to help meet the credit needs of their communities,
including low and moderate-income neighborhoods. In addition, the Equal Credit
Opportunity Act and the Fair Housing Act (together, Fair Lending Laws) prohibit
lenders from discriminating in their lending practices on the basis of
characteristics specified in those statutes. An institution's failure to comply
with the provisions of CRA could, at a minimum, result in regulatory
restrictions on its activities, and failure to comply with the Fair Lending Laws
could result in enforcement actions by the OTS, as well as other federal
regulatory agencies and the Department of Justice. The Bank received a
satisfactory rating during its latest CRA examination in 2003.

Safety and Soundness Guidelines. The OTS and the other federal banking
agencies have established guidelines for safety and soundness, addressing
operational and managerial, as well as compensation matters for insured
financial institutions. Institutions failing to meet these standards are
required to submit compliance plans to their appropriate federal regulators. The
OTS and the other agencies have also established guidelines regarding asset
quality and earnings standards for insured institutions.

Change of Control. Subject to certain limited exceptions, no company can
acquire control of a savings association without the prior approval of the OTS,
and no individual may acquire control of a savings association if the OTS
objects. Any company that acquires control of a savings association becomes a
savings and loan holding company subject to extensive registration, examination
and regulation by the OTS. Conclusive control exists, among other ways, when an
acquiring party acquires more than 25% of any class of voting stock of a savings
association or savings and loan holding company, or controls in any manner the
election of a majority of the directors of the company. In addition, a
rebuttable presumption of control exists if, among other things, a person
acquires more than 10% of any class of a savings association or savings and

14

loan holding company's voting stock (or 25% of any class of stock) and, in
either case, any of certain additional control factors exist.

Companies subject to the Bank Holding Company Act of 1956, as amended, that
acquire or own savings associations are no longer defined as savings and loan
holding companies under the HOLA and, therefore, are not generally subject to
supervision and regulation by the OTS. OTS approval is no longer required for a
bank holding company to acquire control of a savings association, although the
OTS has a consultative role with the FRB in examination, enforcement and
acquisition matters.

ITEM 2. PROPERTIES

OFFICES AND PROPERTIES

The following table sets forth certain information relating to Citizens
Financial's offices at December 31, 2004. In addition, the Bank maintains 31
automated teller machines (ATMs), with 26 of such ATMs at the Bank's branch
offices.

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(1) Full service branch facility located in grocery store chain.

(2) Deposits included with office located at 162(nd) Street.

(3) This full service branch facility located in a local grocery store chain
closed on January 22, 2005.

(4) Includes 3,570 square feet of space currently under lease to third party.

(5) Operations Center.

ITEM 3. LEGAL PROCEEDINGS

LEGAL PROCEEDINGS

In 1983, with the assistance of the Federal Savings and Loan Insurance
Corporation (FSLIC) as set forth in an assistance agreement (Assistance
Agreement), the Bank acquired First Federal Savings and Loan Association of East
Chicago, East Chicago, Indiana (East Chicago Savings), and Gary Federal Savings
and Loan Association, Gary, Indiana (Gary Federal). The FSLIC-assisted
supervisory acquisitions of East Chicago Savings and Gary Federal were accounted
for using the purchase method of accounting which resulted in supervisory
goodwill (the excess of cost over the fair value of net assets acquired), an
intangible asset, of $52.9 million, compared to $40.2 million of goodwill as
reported on a generally accepted accounting principles basis. Such goodwill was
included in the Bank's regulatory capital. The Assistance Agreement relating to
the Bank's acquisitions of East Chicago Savings and Gary Federal provided for
the inclusion of supervisory goodwill as an asset on the Bank's balance sheet,
to be amortized over 35 years for regulatory purposes and includable in
regulatory capital. Pursuant to the regulations adopted by the OTS to implement
the Financial Institutions Reform, Recovery and Enforcement Act of 1989
(FIRREA), the regulatory capital requirement for federal savings banks was
increased and the amount of supervisory goodwill that could be included in
regulatory capital decreased significantly. At September 30, 1989, the Bank had
approximately

16

$26.0 million of remaining supervisory goodwill. Even excluding supervisory
goodwill, however, the Bank exceeded the capital requirements of FIRREA at such
date. As of January 1, 1994, the Bank adopted Financial Accounting Standards
Board (FASB) Statement No. 72, Accounting for Certain Acquisitions of Banking or
Thrift Institutions. Upon the adoption of this change in accounting principle,
the Bank wrote down the remaining balance of the goodwill.

On May 13, 1993, the Bank filed suit against the U.S. government seeking
damages and/or other appropriate relief on the grounds, among others, that the
government had breached the terms of the Assistance Agreement. The suit was
filed in the United States Court of Federal Claims and is titled Citizens
Financial Services, FSB, v. United States (Case No. 93-306-C). The Bank was
granted summary judgment on its breach of contract claim, leaving for trial the
issue of damages. The damages case went to trial in June 2004 and concluded in
early July 2004.

The Bank sought damages of more than $20.0 million based on the report and
testimony of its expert witness. The Government's position was that the Bank
suffered no compensable damage as a result of the breach. On March 7, 2005, the
Court of Claims' judge entered judgment in favor of the Government holding that
the Bank was not entitled to recover any damages. The Court of Claims also ruled
that the Government is entitled to recover certain costs from the Bank with
respect to one claim that the Bank had voluntarily dismissed during the
proceeding. At this time, the Company has no information regarding the amount of
cost that the Government may seek to recover from the Bank. Management of the
Company is currently reviewing its options and has 60 days from the date of the
trial court's decision in which to file an appeal. The Bank's cost, including
attorneys' fees, experts' fees, and related expenses of the litigation was
approximately $1.4 million, $183,000 and $258,000 in 2004, 2003 and 2002,
respectively.

The Bank is also in litigation to foreclose on its loans made to a golf
course. The loans total $2.2 million. As a result of the Bank's foreclosure
proceedings, the current owners of the property have attempted to avoid the
foreclosure and collection on the debt and have further counterclaimed for
damages, due to the Bank's alleged bad faith and breach of an alleged oral
agreement with current ownership. While the Bank believes these claims to be
without merit, the loss to the Bank could be substantial in the event the
borrowers prevail on their counterclaim. At this stage, the opposing party has
not made a formal demand for a specific amount of damages. Thus, the Bank cannot
with any certainty determine the total amount at risk or what the amount of any
potential loss might be.

Other than the above-referenced litigation, the Company is involved in
routine legal proceedings occurring in the ordinary course of business, which,
in the aggregate, are believed to be immaterial to the financial condition of
the Company.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

17

PART II.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES

(a) The Company's common stock is traded on the NASDAQ National Market
under the symbol "CITZ". As of December 31, 2004, there were 12,385,322 shares
of common stock outstanding which was held by 2,285 stockholders of record. The
following table sets forth the quarterly share price and dividends paid per
share during each quarter of 2004 and 2003.

The information for equity compensation plans is incorporated by reference
from Item 12 of this Form 10-K.

(b) Not applicable.

(c) During the fourth quarter of 2004, the Company did not repurchase any
shares of its common stock.

ITEM 6. SELECTED FINANCIAL DATA

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(1) The Company's efficiency ratio is a percentage of non-interest expense to
the sum of net interest income and non-interest income excluding gains or
losses on the sale of securities and assets.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

OVERVIEW

During the fourth quarter of 2004, the Company restructured certain of its
FHLB borrowings to reduce interest costs in future years, shorten the duration
of its liabilities, reduce repricing risk, and eliminate the callable feature.
In the debt restructuring, the Company prepaid $400.0 million of its callable
fixed-rate borrowings and replaced that debt with $325.0 million of new
non-callable FHLB borrowings. The Company structured the transaction in a manner
it initially believed, based on its analysis and discussions with the Company's
independent registered public accounting firm, would allow for extinguishment of
debt accounting pursuant to Emerging Issues Task Force No. 96-19, Debtor's
Accounting for a Modification or Exchange of Debt Instruments (EITF 96-19).
Extinguishment of debt accounting would have resulted in the recognition of
$42.0 million in prepayment penalties associated with the restructuring in the
fourth quarter of 2004 as a charge to non-interest expense and significantly
reduced the Company's interest expense in future periods. Subsequent to December
31, 2004, it was determined that the technical requirements for extinguishment
of debt accounting of EITF 96-19 were not satisfied. As a result, the Company
recognized $9.8 million on the early extinguishment of debt as a charge to
non-interest expense during the fourth quarter of 2004 and deferred the
remaining $32.2 million prepayment penalty in accordance with EITF 96-19. During
the fourth quarter of 2004, the Company amortized as an adjustment to the cost
of the new borrowings $2.1 million of interest expense. The remaining $30.1
million of prepayment penalties as of December 31, 2004 will be

20

recognized in interest expense as an adjustment to the cost of the Company's
borrowings in future periods. The increase in interest expense related to the
remaining prepayment penalties is expected to be $14.4 million, $9.6 million,
$4.5 million, $1.5 million and $200,000 in the years ended December 31, 2005,
2006, 2007, 2008 and 2009, respectively. Although the accounting for this
transaction under EITF 96-19 did not allow the Company to reduce its interest
costs immediately, the Company anticipates the restructuring will have a
positive overall effect in future periods by, among other things, improving the
Company's interest rate risk profile.

During the year ended December 31, 2004, the financial services industry
continued to be impacted by the low interest rate environment. The Company was
able to make strides in increasing its net interest margin by effectively
managing its cost of deposits and redeploying certain lower yielding
interest-earning assets into higher yielding loans. The Company's net interest
income before the provision for losses on loans improved during 2004 to $30.1
million compared to $27.7 million for 2003, an increase of 8.6%. The Company's
net interest margin increased 13.9% to 2.13% for the year ended December 31,
2004 from 1.87% for 2003.

As discussed below, the composition of the Company's loan portfolio has
changed significantly in recent years. The amounts of the Company's commercial
real estate, construction and land development and commercial and industrial
loans have become the predominant types of loans in the Company's loan
portfolio. These types of loans amounted to 60.7%, in the aggregate, of the
total loan portfolio at December 31, 2004 compared to 28.0% at December 31,
2000. See "Changes in Financial Position -- Loan Portfolio Composition" in this
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" below. Commercial loans are generally deemed to involve a greater
degree of risk than single-family residential mortgage loans. During the year
ended December 31, 2004, the Company's charge-offs of commercial real estate,
construction and land development and commercial and industrial loans amounted
to $5.7 million in the aggregate, or 92.2% of total charge-offs for the year.
While the company believes the amount of its allowance for losses on loans at
December 31, 2004 is appropriate, no assurance can be given that additional
charge-offs and or provisions to the allowance for losses on loans may not be
required in the future.

The Company increased its provision for losses on loans by $6.6 million in
2004 compared to 2003, primarily as a result of increased impairment allocations
related to eight loans. In addition, the Company's financial results for 2004
were also adversely impacted by the following:

- legal expenses of $1.4 million related to the Company's goodwill
litigation;

- a $1.0 million impairment of a trust preferred security deemed to be
other than temporarily impaired during the year;

- the write-down of $421,000 in viatical receivables held by the Bank that
were determined to be impaired; and

- an increase in loan collection expenses of $300,000 compared to 2003.

The Company also incurred an additional $1.0 million in compensation
expense related to the resignation of a senior executive officer. This increase,
however, was partially offset by an overall decrease of $1.1 million in pension
related expenses during 2004 as compared to 2003.

CRITICAL ACCOUNTING POLICIES

The Company's consolidated financial statements are prepared in accordance
with U.S. generally accepted accounting principles, which require the Company to
establish various accounting policies. Certain of these accounting policies
require management to make estimates, judgments or assumptions that could have a
material effect on the carrying value of certain assets and liabilities. The
judgments and assumptions used by management are based on historical experience,
projected results, internal cash flow modeling techniques and other factors
which management believes are reasonable under the circumstances.

The Company's significant accounting policies are presented in Note 1 to
the consolidated financial statements included in Item 8 of this Annual Report
on Form 10-K. These policies along with the disclosures
21

presented in the other financial statement notes and in this management's
discussion and analysis, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined. Management views critical accounting policies to be those which are
highly dependent on subjective or complex judgments, estimates and assumptions,
and where changes in those estimates and assumptions could have a significant
impact on the financial statements. Management currently views the determination
of the allowance for losses on loans to be a critical accounting policy.

Allowance for Losses on Loans. The Company maintains an allowance for
losses on loans at a level management believes is sufficient to absorb credit
losses inherent in the loan portfolio. The allowance for losses on loans
represents the Company's estimate of probable incurred losses in the loan
portfolio at each balance sheet date and is based on the review of available and
relevant information.

One component of the allowance for losses on loans contains allocations for
probable inherent but undetected losses within various pools of loans with
similar characteristics pursuant to Statement of Financial Accounting Standards
No. (SFAS) 5, Accounting for Contingencies. This component is based in part on
certain loss factors applied to various loan pools as stratified by the Company.
In determining the appropriate loss factors for these loan pools, management
considers historical charge-offs and recoveries; levels of and trends in
delinquencies, impaired loans and other classified loans; concentrations of
credit within the commercial loan portfolios; volume and type of lending; and
current and anticipated economic conditions.

The second component of the allowance for losses on loans contains
allocations for probable losses that have been identified relating to specific
borrowing relationships pursuant to SFAS 114, Accounting by Creditors for
Impairment of a Loan. This component of the allowance for losses on loans
consists of expected losses resulting in specific credit allocations for
individual loans not considered within the above mentioned loan pools. The
analysis on each loan involves a high degree of judgment in estimating the
amount of the loss associated with the loan, including the estimation of the
amount and timing of future cash flows and collateral values.

Loan losses are charged off against the allowance, while recoveries of
amounts previously charged off are credited to the allowance. The Company
assesses the adequacy of the allowance for losses on loans on a quarterly basis
and adjusts the allowance for losses on loans by recording a provision for
losses on loans in an amount sufficient to maintain the allowance at an
appropriate level. The evaluation of the adequacy of the allowance for losses on
loans is inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available or as future events
occur. To the extent that actual outcomes differ from management estimates, an
additional provision for losses on loans could be required that could adversely
affect earnings or the Company's financial position in future periods. In
addition, various regulatory agencies, as an integral part of their examination
processes, periodically review the provision for losses on loans for Citizens
and the carrying value of its other non-performing assets, based on information
available to them at the time of their examinations. Any of these agencies could
require the Bank to make additional provisions for losses on loans in the
future.

AVERAGE BALANCES, NET INTEREST INCOME, YIELDS EARNED AND RATES PAID

The table on the following page provides information regarding (i) the
Company's interest income recognized from interest-earning assets and their
related average yields; (ii) the amount of interest expense realized on
interest-bearing liabilities and their related average rates; (iii) net interest
income; (iv) interest rate spread; and (v) net interest margin. Information is
based on average daily balances during the indicated periods.

22

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(1) The average balance of loans receivable includes non-performing loans,
interest on which is recognized on a cash basis.

(2) Average balances of securities are based on historical costs.

(3) Includes money market accounts, federal funds sold and interest-earning bank
deposits.

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RATE/VOLUME ANALYSIS

The following table details the effects of changing rates and volumes on
the Company's net interest income. Information is provided with respect to (i)
effects on interest income attributable to changes in rate (changes in rate
multiplied by prior volume); (ii) effects on interest income attributable to
changes in volume (changes in volume multiplied by prior rate); and (iii)
changes in rate/volume (changes in rate multiplied by changes in volume).

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003

Net Income. The Company recognized a net loss for the year ended December
31, 2004 of $6.6 million, or a $0.57 loss per share, compared to net income of
$3.5 million, or $0.30 per diluted share ($0.31 per basic share), for the year
ended December 31, 2003. The net loss was primarily a result of a $9.8 million
charge to non-interest expense related to the Company's $400.0 million debt
restructure which occurred during the fourth quarter of 2004 and an increase in
the provision for losses on loans to $8.9 million from $2.3 million for the year
ended December 31, 2003.

Also adversely impacting the Company's results for the year ended December
31, 2004 were the following:

- legal expenses of $1.4 million related to the Company's goodwill
litigation;

- a $1.0 million impairment of a trust preferred security deemed to be
other than temporarily impaired during the year;

24

- the write-down of $421,000 in viatical receivables held by the Bank that
were determined to be impaired; and

- an increase in loan collection expenses of $300,000 compared to 2003.

The Company also incurred an additional $1.0 million in compensation
expense related to the resignation of a senior executive officer. However, this
increase was partially offset by an overall decrease of $1.1 million in pension
related expenses during 2004 as compared to 2003.

Net Interest Income. Net interest income before the provision for losses
on loans is the principal source of earnings for the Company and consists of
interest income received on loans and investment securities less interest
expense paid on deposits and borrowed funds. Net interest income is a function
of the Company's interest rate spread, which is the difference between the
average yield earned on the Company's interest-earning assets and the average
rate paid on its interest-bearing liabilities, and the relative amounts of
interest-earning assets and interest-bearing liabilities.

The Company's net interest margin, which is net interest income as a
percentage of average interest-earning assets, for the year ended 2004 improved
13.9% to 2.13% from 1.87% for 2003. The Company's net interest income before the
provision for losses on loans for the year ended December 31, 2004 totaled $30.1
million and represented an 8.6% increase from $27.7 million for the year ended
December 31, 2003. The increase in the net interest income and the net interest
margin for the year was mainly the result of effective management of the cost of
deposits combined with the redeployment of lower yielding other interest-earning
assets into higher yielding loans. Although the Company refinanced its FHLB debt
at lower fixed-rates, the amortization of a portion of the prepayment penalties
negatively impacted the net interest margin for the year ended December 31,
2004. The Company expects the net interest margin to continue to be adversely
impacted as a direct result of the amortization through interest expense of the
remaining prepayment penalty during 2005 and in future years.

Interest Income. The Company reported total interest income of $69.0
million for the year ended December 31, 2004 compared to $71.4 million for the
year ended December 31, 2003. The decrease was primarily due to a 4.9% decrease
in average interest-earning assets during 2004 from 2003 which was partially
offset by a slight increase of 8 basis points in the yield of average
interest-earning assets. The Company was able to redeploy certain lower yielding
interest-earning assets into higher yielding loans throughout 2004 as well as
use some of the repayments received on lower yielding assets to prepay a portion
of its FHLB borrowings.

During the year ended December 31, 2004 compared to the previous year, the
Company's average loan balances increased $33.3 million or 3.5% while the
average balance of the Company's other interest-earning assets (including the
Company's money market accounts, federal funds sold and interest-bearing bank
deposits) decreased $107.6 million or 60.0%.

Interest Expense. During 2004, the Company proactively managed its cost of
interest-bearing deposits and borrowings and reduced interest expense by $4.8
million or 10.9% as compared to 2003. Total interest expense amounted to $38.9
million for the year ended December 31, 2004 compared to $43.7 million for the
year ended December 31, 2003. Interest expense on deposits decreased 25.7% to
$12.8 million during 2004 from 2003 primarily as a result of a 42 basis point
reduction in the average rate paid on total deposits coupled with a $47.4
million decrease in the average balance of total deposits. The Company continues
to focus on increasing core deposits as a means of managing its total cost of
deposits.

Interest expense on borrowings during 2004 decreased by $343,000 from 2003
primarily as a result of the overall lower average level of debt during 2004.
Included in interest expense in 2004 is the amortization of $2.1 million in
prepayment penalties recognized as a result of the debt restructuring completed
in the fourth quarter of 2004. The Company expects that the fourth quarter
restructuring of the FHLB advances will continue to impact interest expense as
the remaining prepayment penalties are amortized as an adjustment to the cost of
the new borrowings. Additional interest expense related to the amortization of
the remaining prepayment penalties is expected to be $14.4 million, $9.6
million, $4.5 million, $1.5 million and $200,000 in the years ended December 31,
2005, 2006, 2007, 2008 and 2009, respectively.

25

Provision for Losses on Loans. The Company's provision for losses on loans
was $8.9 million for the year ended December 31, 2004 compared to $2.3 million
in 2003. The $6.6 million increase in the provision was mainly the result of the
Company's increased impairment allocation for impaired loans coupled with an
increase in the amount of loan charge-offs during 2004.

During 2004, the Company identified eight impaired loans with a total
aggregate balance of $31.9 million. The aggregate required impairment allocation
was $10.3 million, an increase from the previous allocation of $3.8 million for
these loans. Each of these eight loans was reviewed for impairment based upon
updated information received in conjunction with its overall evaluation of the
adequacy of the allowance for losses on loans. This updated information
identified either a change in the borrower's ability to perform their loan
obligations or in the estimated value of the collateral. See additional
information regarding the increases in the provision included in the "Allowance
for Losses on Loans" sect